THREATS OF BANKRUPTCY AND DEBTOR-CREDITOR RELATIONS IN THE TIME OF COVID-19
The COVID-19 pandemic has created difficulties for businesses of all sizes in all industries. As a result, an increase in the number of businesses seeking bankruptcy protection is to be expected. Even those businesses that do not need bankruptcy protection are likely to see increases in interactions with other companies that cannot pay their own bills, or are facing bankruptcy. In these uncertain times, it is important to be aware of recent changes to the bankruptcy law that may impact businesses positioned as a debtor or creditor.
The Small Business Reorganization Act (the “SBRA”)
The most common bankruptcy elections made by businesses are under Chapter 7 (liquidation) or Chapter 11 (reorganization) of the Bankruptcy Code. Chapter 11 is often the preferred approach because it allows a business to continue operating while adjusting its financial obligations through reorganization. Traditional Chapter 11 cases, however, are often not feasible for small businesses because of the time, administrative expense, and often a significant legal cost of maneuvering the process.
To reduce the drawbacks for small businesses of a traditional Chapter 11 bankruptcy case, Congress enacted the SBRA, which became effective in February 2020. The SBRA added a new subchapter to Chapter 11 of the Bankruptcy Code which allows qualified small business debtors to proceed under Chapter 11 with modified rules. In order to qualify as a small business debtor under the SBRA, a company must generally:
- Engage in commercial business (other than owning single asset real estate); and
- Have no more than $2,725,625 in noncontingent, liquidated, secured, and unsecured debt.
The modified rules for qualified small business debtors are intended to expedite the Chapter 11 process, reduce legal and other reorganization costs, and minimize the time and expense required to confirm a plan of reorganization. Some of the key modifications include:
- Requiring that a trustee be appointed in every small business Chapter 11 case. The trustee serves primarily in an advisory role and assists the debtor in a developing a plan of reorganization and is responsible for disbursing payments.
- There is no unsecured creditors’ committee unless ordered by the court, for cause.
- The debtor is not required to file a disclosure statement unless ordered to do so by the court.
- Only the debtor may file a plan of reorganization and the plan must be filed within 90 days of the date the debtor filed bankruptcy.
- The debtor may stretch payment of administrative expense claims out over the term of the plan.
Impact of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) on the SBRA
The CARES Act expands the availability of the SBRA by increasing the debt limitation for qualified small business debtors. Specifically, the CARES Act increases the limitation from $2,725,625 (as provided in the SBRA) to $7,500,000. The increased debt limitation currently applies through March 27, 2021.
What Creditors Need to Know
It is important for businesses to be aware of the potential effect of a bankruptcy filing by a party with whom it does business – particularly in light of today’s climate and the fact that the SCRA and the CARES Act both make bankruptcy a more feasible option. While there are numerous issues that may arise in any bankruptcy, two particular considerations play a role in almost every bankruptcy case.
First, a business must assess whether it will be subject to a preference claim by the bankruptcy estate. Any payment that is received by a business within the 90 days before a debtor files bankruptcy may be deemed a preference. In that situation, the bankruptcy estate is entitled to seek recovery of the amount paid by the debtor during the 90-day preference period. A payment made within the foregoing timeframe, however, is not automatically deemed a preference, so it is important for a business to consult with counsel to determine if a received payment may be subject to an exception.
Second, if a business is owed money by a debtor at the time of the bankruptcy filing, the business will have to file a proof of claim in the debtor’s bankruptcy case. Typically, a deadline to file a proof of claim is set early in the bankruptcy case. If a creditor fails to file a timely proof of claim or its proof of claim is deemed deficient, it may be precluded from recovering the amounts due to it through the bankruptcy process. As such, it is important for a business to be aware of any proof of claim deadline and what it needs to submit in relation to its proof of claim.
We are available to assist businesses that need more information about seeking bankruptcy protection or how to maneuver the bankruptcy process as a creditor. Do not hesitate to contact us to address any issues that may be encountered.